# Can Time-Varying Risk of Rare Disasters Explain Aggregate Stock Market Volatility?

@article{Wachter2008CanTR, title={Can Time-Varying Risk of Rare Disasters Explain Aggregate Stock Market Volatility?}, author={Jessica A. Wachter}, journal={AFA 2011 Denver Meetings (Archive)}, year={2008} }

Why is the equity premium so high, and why are stocks so volatile? Why are stock returns in excess of government bill rates predictable? This paper proposes an answer to these questions based on a time-varying probability of a consumption disaster. In the model, aggregate consumption follows a normal distribution with low volatility most of the time, but with some probability of a consumption realization far out in the left tail. The possibility of this poor outcome substantially increases the… Expand

#### 718 Citations

The Time-Varying Risk of Macroeconomic Disasters

- Economics
- 2017

While time-varying disasters can explain many characteristics of financial markets, their quantitative assessment is still missing. We propose a latent variable approach to estimate the time-varying… Expand

Rare Booms and Disasters in a Multi-Sector Endowment Economy

- Economics
- 2015

Why do value stocks have higher average returns than growth stocks, despite having lower risk? Why do these stocks exhibit positive abnormal performance while growth stocks exhibit negative abnormal… Expand

Option Prices in a Model with Stochastic Disaster Risk

- Computer Science, Economics
- Manag. Sci.
- 2019

This model assumes a small risk of a rare disaster that is calibrated based on the international data on large consumption declines and allows the risk of this rare disaster to be stochastic, which turns out to be crucial to the model's ability to explain both equity volatility and option prices. Expand

Time-varying rare disaster risk and stock returns

- Economics
- 2011

This study provides empirical support for theoretical models that allow for time-varying rare disaster risk. Using a database of 447 international political crises during the period 1918-2006, we… Expand

Asset Pricing Implications of Volatility Term Structure Risk

- Economics
- 2014

I find that stocks with high sensitivities to changes in the VIX slope exhibit high returns on average. The price of VIX slope risk is approximately 2.5% annually, statistically significant and… Expand

Asset Prices in Turbulent Markets with Rare Disasters

- Economics
- 2013

I propose a parsimonious econometric model for the stochastic process governing the evolution of per capita consumption and stock market dividend over time. The model features stochastic volatility… Expand

Time Varying Pessimism , Rare Disasters and Stock Returns

- 2013

Recent financial literature has advocated the risk of rare disasters to explain the equity premium puzzle (Mehra and Prescott (1985)). This paper presents a model with rare consumption disasters,… Expand

Rare Booms and Disasters in a Multi-Sector Endowment Economy

- Economics
- 2014

Why do value stocks have higher average returns than growth stocks, despite having lower risk? Why do these stocks exhibit positive abnormal performance, while growth stocks exhibit negative abnormal… Expand

The role of time‐varying rare disaster risks in predicting bond returns and volatility

- Economics
- 2019

This paper aims to provide empirical evidence to the theoretical claim that rare disaster risks affect government bond market movements. Using a nonparametric quantiles-based methodology, we show… Expand

Asset pricing with time varying pessimism and rare disasters

- Economics
- International Review of Economics & Finance
- 2019

Abstract We incorporate time-varying consumption volatility in the representative-agent asset pricing model with generalized recursive smooth ambiguity preferences developed by Ju and Miao (2012). We… Expand

#### References

SHOWING 1-10 OF 100 REFERENCES

Why Does Stock Market Volatility Change Over Time?

- Economics
- 1988

This paper analyzes the relation of stock volatility with real and nominal macroeconomic volatility, financial leverage, stock trading activity, default risk, and firm profitability using monthly… Expand

Risks for the Long Run: A Potential Resolution of Asset Pricing Puzzles

- Economics
- 2000

We model consumption and dividend growth rates as containing (1) a small longrun predictable component, and (2) fluctuating economic uncertainty (consumption volatility). These dynamics, for which we… Expand

Variable Rare Disasters: An Exactly Solved Framework for Ten Puzzles in Macro-Finance

- Economics
- 2008

This paper incorporates a time-varying intensity of disasters in the Rietz-Barro hypothesis that risk premia result from the possibility of rare, large disasters. During a disaster, an asset’s… Expand

Crashes, Volatility, and the Equity Premium: Lessons from S&P 500 Options

- Economics
- The Review of Economics and Statistics
- 2010

We use a novel pricing model to imply time series of diffusive volatility and jump intensity from S&P 500 index options. These two measures capture the ex ante risk assessed by investors. Using a… Expand

Why is Long-Horizon Equity Less Risky? A Duration-Based Explanation of the Value Premium

- Economics
- 2005

This paper proposes a dynamic risk-based model that captures the high expected returns on value stocks relative to growth stocks, and the failure of the capital asset pricing model to explain these… Expand

Stock-Market Crashes and Depressions

- Economics
- 2009

Stock-market crashes are informative about the prospects for macroeconomic depressions. Long-term data for 30 countries reveal that, conditional on a crash, the probability of a minor depression is… Expand

Predicting returns in the stock and bond markets

- Economics
- 1986

Abstract Several predetermined variables that reflect levels of bond and stock prices appear to predict returns on common stocks of firms of various sizes, long-term bonds of various default risks,… Expand

Why is Long-Horizon Equity Less Risky? A Duration-Based Explanation of the Value Premium

- Economics
- 2007

We propose a dynamic risk-based model that captures the value premium. Firms are modeled as long-lived assets distinguished by the timing of cash flows. The stochastic discount factor is specified so… Expand

Stochastic Volatility in General Equilibrium

- Economics
- 2004

The connections between stock market volatility and returns are studied within the context of a general equilibrium framework. The framework rules outa prioriany purely statistical relationship… Expand

The Peso problem hypothesis and stock market returns

- Economics
- 2004

Abstract The Peso problem hypothesis has often been advocated in the financial literature to explain the historically puzzlingly high risk premium of stock returns. Using a dynamic model of learning,… Expand